Huntington Bancshares Incorporated (HBAN) Earnings Call Transcript & Summary

All right. Good morning. I'm Manan Gosalia, the mid-cap banks analyst at Morgan Stanley. On behalf of the entire Morgan Stanley Financials team, I'd like to welcome everyone here to the 14th Annual Morgan Stanley Financials Conference. We've got a great lineup over the next 3 days with 145 companies in attendance. A quick disclosure before we kick off. For important disclosures, please see the Morgan Stanley Research Disclosure website at morganstanley.com/researchdisclosures. The taking photographs and use of recording devices is not allowed. And if you have any questions, please reach out to your Morgan Stanley sales representative. And kicking off the conference, I'm delighted to have with us today Huntington's, Chief Financial Officer, Zach Wasserman. Zach will kick off with a few prepared remarks, and then we'll go into Q&A. Zach, over to you.

Good morning. Thank you, Manan and Morgan Stanley for hosting us today. I want to welcome everyone. We appreciate your interest in Huntington. Before we get started, please review Slide 2, which applies to the forward-looking statements we'll make today. Let me begin today with a few comments related to our strategy and recent initiatives. Then I'll turn it back over to Manan for Q&A. Let's start on Slide 3. At Huntington, we live our purpose every day. We have a clear vision to become the country's leading people-first, digitally-powered bank. On Slide 4, there are 4 key messages I'd like to share with you today. First, the cumulative effect of the actions we've taken over the last decade, places Huntington in a position of strength as we navigate this environment. As we saw in our first quarter results, our deposit franchise is top tier. Second, our approach is guided by our aggregate, moderate to low risk appetite through the cycle. Third, we remain nimble as we dynamically manage through this environment. And fourth, Huntington's management team is a group of disciplined operators with a track record of execution. This focus on delivering results permeates the organization and drives execution of our strategy and continued top quartile performance. Turning to Slide 5. We operate in this period from a position of strength. Our core strategy is centered on acquiring and deepening primary bank relationships. We have an incredibly strong track record of customer service and product innovation. The success of these efforts is reflected in being recognized by J.D. Power for #1 in Customer Satisfaction, 7 out of the past 11 years, and for being awarded the #1 Mobile App ranking by J.D. Power, again for the fifth consecutive year. Our liquidity continues to be robust. Our 2 primary sources of liquidity, cash and borrowing capacity at the FHLB and Federal Reserve represented roughly $86 billion as of May 31. This pool of available liquidity represented 191% of uninsured deposits, peer-leading coverage. Our capital remains solid. We expect to continue to build CET1 to the high end of our 9% to 10% operating range through year-end. Our credit reserves are top tier in the peer group at 1.9% and net charge-offs for the last 12 months were 13 basis points compared to the peer median of 22 basis points. Our strength in deposits, liquidity, capital and credit are the results of disciplined execution. Importantly, this strength supports our ability to capture opportunities as they arise in the current environment. Our announcement this past Friday of our fund finance team lift-out is a great example of that. Moving on to Slide 6. Over the last 5 quarters, we've consistently delivered deposit growth despite the backdrop of rising rates and quantitative tightening. Through the first quarter of the year, cumulative deposit growth was 2.7%, over 7 percentage points better than the peer median. During March, we saw stability of deposit balances with growth through mid-April, as we shared on our earnings call. We have seen that deposit growth continue through the end of May as total deposits have increased $2.8 billion compared to March 31. On Slide 7, we are expanding capital and our CET1 ratio over the course of the year, while maintaining our top priority to fund high-return loan growth. We intend to drive CET1 to the top end of our 9% to 10% range by the end of the year. Adjusting for AOCI, our adjusted CET1 was 7.9% at the end of the first quarter and places Huntington in the top quartile of the peer group. Turning to Slide 8. We have mentioned how we are optimizing loan growth to generate the highest return on capital. As we balance the desire to grow loans and build the revenue base, along with our outlook to expand capital over the course of the year, we're remaining disciplined to ensure we generate solid NIM and return on capital from incremental loans. We have incrementally tuned our loan production to a rate which can support ongoing revenue growth while also supporting growing capital levels. We continue to be dynamic to manage that balance. Turning to Slide 9. Our loan portfolio is highly diversified and provides for consistency of performance through the cycle. As mentioned previously, our ACL is strong at 1.9%. Turning to Slide 10. I want to highlight the focus areas for our financial management in 2023. In deposits, our strategy of acquiring and deepening primary bank relationships is working to drive sustained deposit growth. We expect to see deposit growth in Q2 on an ending basis, and we forecast deposit growth for the entire year within our prior range. We're driving capital to the high end of our 9% to 10% operating range over the course of the year, as I've mentioned. One of the key levers to do that is our optimization of loan growth and calibrating production levels. Our outlook for full year loan growth is unchanged at the low end of our 5% to 7% prior guidance, while we will slow that growth in the back half of the year. On funding, the interest rate environment is playing out along the higher for longer scenario. And as we -- and we now expect deposit beta to be a couple percentage points higher than what we shared in April, now approaching 40%. Given our modulation of loan production and the increased likelihood of higher for longer interest rate environment, as well as higher funding costs, our current forecast would indicate spread revenue growth just below our prior guidance of 6% to 9%. On hedging, we've been active this quarter and entered into economic hedges to protect capital from tail risk in substantive uprate scenarios. There's an upfront premium associated with these hedges and the results in a mark-to-market each quarter. Currently, we're in a modest gain position that would flow through fee revenue. As a result of optimized loan growth and recent trends of lower capital markets activity, impacted at an industry level from the uncertainties around the national debt ceiling last month, we do see some level of pressure on fee income in the near term. However, there is a lot of the year left to play out, and we expect to see sequential growth over the remainder of this year. On expenses, we remain committed to driving a very low level of underlying expense growth, while maintaining critical long-term investments. We'll be dynamic in expense management, contingent on the revenue outlook. Net charge-offs continued to perform exceptionally well, and we're on track for our full year outlook. Lastly, on preferred dividends, I want to highlight that we had a new issuance last quarter and an existing tranche moving from fixed to floating rate, which will result in our quarterly run rate stepping up slightly into Q2. With those opening remarks, let me turn it over to Manan now for the Q&A session.

Thanks so much, Zach. Maybe to drill down into some of your comments on deposits, given that's where a lot of the investor interest is. You mentioned that deposits are doing well. I think quarter-to-date, your deposits are up 2%. I think you spoke about how 1% to 3% for the full year is still the right range. Is that correct?

That is correct. I think on deposits, as I mentioned in my prepared remarks, we're fundamentally focused on our strategy of acquiring and deepening primary bank relationships and it's working. In the first quarter, I mentioned on our earnings call in April that we saw 2% growth in consumer households, 4% growth year-on-year in business banking households. And we're also continuing to gather and win new names on our commercial business. And so, that's the fundamental underpinning. And then on top of that, we've been actively working to deepen those relationships through a number of other products and channels post acquisition. So that's working. It's contributing to the growth we saw throughout April and into May. For the full year, the guidance we've given before, which we still think is appropriate is growth between 1% and 3% for 2023, which will largely be consumer-led at this point and continue to feel a solid line of sight to that.

Perfect. I do want to dig into the consumer versus commercial angle. But before that, maybe just talking about the mix of deposits between non-interest-bearing and interest-bearing. I think you ended the year at about -- you ended 1Q at about 25%, which is already close to the low in the prior cycle. The questions we get on how low can that go? If that stays higher for longer, would you be able to share some thoughts on that?

Sure. Yes. It's a great question. In the past cycle between 2017 and 2019, we saw non-interest-bearing deposits move from around 30% at the beginning of the cycle to 25% at the end of the cycle. So it's down about 5 percentage points in terms of a mix shift last time. This time, we've seen slightly less change than that thus far from 29% at the beginning of this cycle to 25%, so about a 4% delta. We do expect that overall, the mix shifts and the funding base will trend in not a significantly dissimilar level to what we've seen in past cycles. But likely, to your point, a couple more percentage points to go here throughout the course of the cycle if the current forecast play out. So it might be somewhat higher but not really substantively different. I don't see any scenario where we would go back to the level that Huntington was for pre-great financial crisis. The company has changed quite a bit. And we've clearly benefited now for more than a decade of Fair Play strategy and gathering the kind of fundamental and diversified deposit base we have now. But a couple of points probably more to go in that mix shift as we go throughout the next couple of quarters.

Maybe if you can expand on that a little bit because a lot of -- some of the generalist investors I talked to look back to pre-GFC and look at the non-interest-bearing deposit mix then. Can you talk about what the puts and takes are between where you were pre-GFC to where you are now?

Well, I think what has happened over that period is really a fundamental change in the nature of Huntington. Huntington pre-GFC was a $50 billion bank. There was much smaller, less sophisticated, less of a differentiated strategy. Now the company is almost 4x larger. It's -- obviously, it's significantly scaled and more developed franchise. So that's really the fundamental thing that has changed. We've now got a deposit base with millions of customers very significant consumer, a leading business banking franchise, clearly, a strong commercial business as well. And so, it's just a totally different company really at this point.

Got it. And maybe to come back to the comment you made earlier on, on consumer versus commercial. Historically, you have had a larger SKU towards consumer deposits, a lot more than other regional banks. I think consumer makes up about 2/3 of balances. And how big of an advantage is that in this type of an environment in terms of stickiness of those deposits?

Yes. The -- we believe very firmly that the deposit base is the foundation of value of the company, and you can really see it at times like this. And so, the strength of that incredibly granular, diversified, highly insured deposit base that was built as a function of our Fair Play strategy and executing on that over the last decade has puts us in a position now where, to your point, one of the things that came out of the events of March and April, where a shift in the market in terms of commercial deposit gathering became much more expensive, more challenging. The fact that we've got such a premier consumer and business banking deposit franchise gives us the opportunity now to lean into that and to shift the sources from which we expect to drive deposit growth, but ultimately have a forecast, which is virtually unchanged in terms of overall amount of deposit gathering. And what we're seeing is the opportunity to really gather deposits at the margin here that are efficient and that are, as I mentioned before, very much in keeping with that strategy in terms of granular diversified.

And how much of that is coming from the core business versus also your strategy to gain share in new TCF markets like Chicago, the Twin Cities, Denver, that you've spoken about before?

In terms of the composition of deposit growth, it's highly diversified across the whole footprint and clearly, the established markets that we've had, pre-TCF acquisition contribute very significantly to that growth. With that being said, the TCF markets are doing terrific. And it's not surprising to us. We have been talking with all of you over time about how powerful the opportunities for revenue synergies were coming out of the TCF acquisition. And a large chunk of them around 1/3 of that synergy opportunity was in consumer. And it was about penetrating into those acquired geographies, think Southeast Michigan, Denver, Chicago with the Huntington brand and product set, we've been increasing marketing and leveraging our really sophisticated marketing technology capabilities to target and acquire customers in those areas. It's about raising branch productivity. The TCF branches were in phenomenal locations. Great, great branch presence. And they were a solid sort of average level of production, Huntington was at a whole other level. And so, bringing the Huntington product set, the service ethos, the capabilities to that branch network likewise are resulting in really significant increases in productivity. And ultimately, it all comes back to the results we've been seeing, which you can see is right on there in the page, it's really been working.

And then are there any other levers to grow deposits on the consumer side? I think previously you mentioned increasing marketing spend. I feel like a lot of other peers are pulling back on marketing spend right now, given the focus on expenses. So can you talk about how that's translating into household growth right now?

Sure. One of the key things that we're focused on at this point, given the uncertainty in the market, the turbulence in the banking industry is just staying focused on our strategy and knowing that it's the right strategy to continue to win and the performance will come through over time. And so, that commitment to drive marketing growth is an indication around that. We're not going to stop executing our growth plan, and it's really bearing fruit. In the first quarter, we increased marketing more than 13.5% year-on-year. The average and the median in the peer group was down 6.5%. So a huge delta in marketing acquisition. And so, that's certainly a contributing factor to why we're continuing to acquire accounts, consumer, business banking, as I mentioned, and be successful in gathering the deposits that come along with that.

All right. Perfect. So maybe to dig down a little bit into some of the guidance you gave for the quarter earlier on. Maybe to start with on net interest income and deposit betas. I think you mentioned deposit betas closer to 40%, net interest income a little bit lower than your prior range of 6% to 9%. Can you talk about -- a little bit more about what's driving that and what the environment is like right now?

Sure. On deposit beta, maybe just touch on that for a second. Clearly, I think we mentioned in Q1 that we always plan with a variety of interest rate scenarios to understand what our strategies would be and what the implications would be. And it appears more and more that the actual environment is playing out along the top end of our scenario outlook in a higher for longer scenario. And as we've said, likely that will result in a longer beta cycle if rates are higher for longer. And potentially, if the peak is higher, somewhat higher level. And so, that's sort of what's underlying the latest forecast we've got. I will tell you, any time I talk about beta, I always try to stress that it's important to have a long-term forecast. And we want to make sure we're monitoring and tracking to that forecast. But clearly, there's a range of uncertainty, and it will be -- ultimately, how it plays out will be a function of how exactly the interest rate environment plays out. With that being said, we think that even as interest costs are somewhat higher, so are asset yields. And we're being very, very conscious in driving for incremental loan production that will drive really solid incremental NIMs and incremental returns. And so, we do think it's an accretive scenario over long term to asset yield as well. But clearly, given the slightly tuned loan growth that we have in the back half of the year and the slightly higher funding cost, we'll see spread revenues just a little bit lower than the prior guidance range that we had provided before.

And maybe to drill down into those data comments a little bit. In the event that we get -- the Fed stays higher for longer. We say we've reached a beat now or we get one more hike and we reach peak then. How do you think about the trajectory of your deposit beta as the deposit costs keep rising through the year?

We'll see, Manan, I think is the answer. At this point, we're planning that the most likely scenario is that, there's one more hike and then sort of a pause out through the end of the year into probably likely the early part of next year, if not even the middle part of next year. And in that scenario, I think you'll see deposit costs rising throughout the course of the year. I think the velocity of them will be slowing, right? And so, I think that you'll see sort of an asymptotic function over the next several quarters here. And ultimately, again, how it plays out over the really longer term, will be a function of what's going on in early '24 and beyond. But again, likewise, there will be a commensurate movement in asset yields as well that we'll make sure we manage carefully.

So on the point on asset yields and loan spreads, what's keeping loan spreads elevated? Is it the lack of competition? Is it more banks recognizing the fact that cost of funds is going up?

Look, there's a lot of factors, I think, that are playing into right now, what's going on in loan demand and loan pricing. Certainly, an element is a very conscious focus from what we can perceive certainly from us, but I think in the peer group and banking more broadly to really be careful in how capital is being allocated so that capital can both grow organically and support the highest return on loan growth. And so, I think there's a fairly disciplined environment underway at this point. Clearly, we are also being very judicious about where we're driving that growth, not only to get the best returns, but also to make sure that it's very much in keeping with our strategy. For Huntington, the growth we expect in loans this year is largely commercial led. And it's in 3 big places in our corporate and specialty banking division, where we've been building out. We've been investing to build capabilities and so to see modest growth coming through is just what you would expect in terms of driving the return on those investments. Second place is our asset and equipment finance business. When -- we've talked about this a number of times in other conferences, when we brought the Huntington and TCF asset and equipment finance businesses together, we built one of the strongest franchises in the country, and we are seeing that now play through in solid sustained growth in that loan production, which is not surprising. There's a long secular trend underway of businesses reinvesting in their property, plant and equipment to automate supply -- labor, supply challenges, drive efficiencies, which we'll really benefit from. And then lastly, it's the line utilization that we're seeing in our vehicle finance floor plan business and our distribution finance business, which just the supply of goods coming out of manufacturers is incrementally improving as supply chain challenges wane. So that's where we're seeing the growth come through.

And then while we're on the topic of loan growth, on Friday, you announced that Huntington added a new 10-person fund banking team to strengthen the sponsor business. Can you give us a brief overview of that and how that fits into your longer-term strategy?

Sure. We're really, really excited about this and so pleased to be able to welcome 10 new colleagues to Huntington. So welcome team. This is a fund finance business that was most recently at Signature Bank, but before that in Bank of America and Wells Fargo. So a great track record of performance over time. And for us, it's not only -- a sort of example of staying on our front foot being opportunistic in this environment, leveraging our strength now to capture opportunities, but also very much in keeping with our strategy of continuing to build out specialty disciplines and expertise verticals within our commercial banking business. And so, we feel really excited about what this team can do. The capital call lending business is one that comes with generally really good spreads, very low historical charge-offs and a great opportunity to build deposits and to drive treasury management revenues. And so, feel really good about where that business will be. We have a small business now in that area. So this will enable us to expand it. And I would expect over the moderate term for that business to get to the between 1% and 2% of total Huntington loans over time. So a contributor.

And you would be opportunistic in hiring more teams if the opportunity was available?

Potentially, yes.

All right. Perfect. Maybe just digging into the fees side, I think you mentioned some pressure near term on fees and maybe a little bit of a rebound in the back half of the year. Can you drill down into that a little bit, talk about your strategy there and talk about what should be driving that growth towards the back half of the year?

Yes. So I think we've talked about fees a lot, and we expect them to be around 1/5 of the overall profit growth for the company over time. So a critical part of the strategy, both financially, but also importantly, around deepening relationships and really wrapping our full arms around our clients and providing them all the services to make them sticky and loyal to the company. And so, it's really critical on 3 big areas: capital markets, payments and wealth management. On capital markets, which has just been on an absolute tear for the last 5 to 7 quarters. We are seeing not surprisingly given the environment, some lower activities, but continue to be pretty sanguine about where that will go over the coming quarters. And I think we're beginning to see that now strong pipelines in our Capstone business and solid underlying trends in our core capital markets business. So that will be a driver of sequential growth. I think payments continues to perform very well. We've got a top-tier debit, small but growing credit card business and our treasury management activity continues to be very successful in penetrating new customers. And so, we'll see that contribute to growth. And then wealth management. Wealth is an area we've highlighted quite a bit, we're 1% penetrated in terms of our wealth offerings and our customers as of the end of last year. The typical regional bank is 3% to 5% penetration. And so, for us, just achieving the average level will represent more than $100 million revenue opportunity. And it's really working. We're right sizing the kind of the go-to-market approach between our private bank and our financial advisers business. In the first quarter, you saw us make yet another announcement about that, bringing those 2 businesses together into the same unit to really continue to harmonize the go-to-market approach, which is really bearing fruit. We're investing significantly in digital capabilities for clients to connect with their advisers. And ultimately, it's all driving towards assets under management growth, which for us on a quarterly basis, continue to set new records internally in terms of net asset flows into assets under management. So those will be the things that really drive sequential growth from here and feel really good about where that fee business will go over the -- not only the back half of this year, but in the longer term as a really powerful way to supplement return on capital.

And these investments are baked into your expense guide for the year?

They are, they are. So within our expense guidance, we talked about a core underlying expense growth of around 1% to 3%. And that's even as revenue is growing much faster than that. And for us, it's about -- in expenses, it's about being very planful, anticipating what likely will be the revenue trajectory and taking actions to make sure that we're keeping overall expense growth at a low level, even as investments within that overall expense growth, investments in tech and marketing, as I said, growing year-on-year in select new additions of personnel, but those are continuing to grow at a much faster rate to support the revenue trajectory over the moderate term.

Perfect. I want to drill into credit a little bit. That's another topic that's been front and center for investors. At earnings, I think you highlighted a lot of positive asset quality trends, whether it's on the non-performing loan side, the criticized asset side. Can you talk about what you're seeing in 2Q and what the main areas of focus are?

Absolutely. Overall, credit continues to perform exceptionally well, really very, very strong. We're operating with an extremely heightened degree of vigilance, not surprisingly, given the prospect of a recession on the horizon. But for us, we are very focused on underwriting through a cycle. And so, it allows us to not make substantive changes on our underwriting posture at times like this, but rather just to lean in and just go even deeper in terms of portfolio reviews, and it's almost some kind of portfolio review happening virtually every week at this point. And every time we do that, what's coming back is more indications of the fundamental strength of the portfolio and of our clients. So we feel really good about where that is. The expectation for charge-offs this year is to normalize somewhat of the extraordinarily low levels we saw last year, but to continue to be at the low end of our through-the-cycle range of 25 to 45 basis points of net charge-offs, and we continue to see that focus areas across the whole portfolio. So I wouldn't say we're differentially focused overly on any area, but clearly focused on CRE, on the small business portfolio, on areas like leveraged lending, which for us are already a really small area. And again, portfolio generally looks really, really good. And I would tell you as well, we feel great about the fact that our credit reserve of 1.9% is very sufficiently sized to deal with anything that might come up.

So on the CRE side, offices where most of the focus has been. I think you mentioned that office is less than 2% of your total loans, and most of it is in suburban areas. So can you talk about where you see the risk there and how you're tackling that?

Yes. For us, CRE overall, including commercial REITs, it's about 14% of total loans. If you were to exclude commercial REITs, which are for the most part of the way the peer group reports is typically excluding commercial REITs is 11% of total loans, which is at the lower end of the peer group in terms of overall size of CRE. As you noted, most of it is multifamily or industrial. The piece that's office is very small, less than 2% of total loans. Most of it is suburban, most of it is multi-tenanted. For us, we're very focused on CRE overall. Over the last 10 years, we've made a very concerted movement to the point where we have a much more concentrated portfolio in terms of really strong sponsors, deep, deep experience in this space, strong relationships with us, and we feel like the sponsor backing is extraordinary. In office, I think the thing that we're focused on is, what are the lease expirations that fundamentally are going to drive revenue. And those are typically 5 to 7 to 8 to longer leases. So we're not seeing any more than high-single digits in terms of lease rolls over the next 5 years, which will allow time for properties to manage through. There will be some issues, and we'll have to kind of address them as they come up. But we've got a 3% credit reserve on overall CRE 8% on office. So we think that those -- coupled with the strength of the underlying book leaves us in a really good place to have captured that loss content already.

All right. So, Zach, I'm going to drill in a little bit on regulation and buybacks and then quickly open to the audience if there is a question or 2 in the room. On buybacks, I think you've been pretty clear that you want to get to the high end of your CET1 target. How does the uncertainty on the regulatory environment feed into that?

We think it's the right plan at this point to put buybacks on pause and continue to drive our capital up to the high end of the CET1 of our operating range towards 10%. And this will be both organic capital build. We saw almost 20 basis points of capital build in Q1. I like to see something similar again really strong in Q2 and continuing up into Q3 and Q4. But also husbanding back and really protecting the AOCI, which doesn't currently get shown up reported in CET1, but clearly, it's in TCE. And we saw 7% of that AOCI come back just in the first quarter. If you look out through 2024, based on the forward yield curve, you'd see about 40% of it come back. And so, those 2 things together will allow us to really increase capital. It's quite likely that there will be a change in the way that AOCI works in terms of CET1 reporting. You saw us in our prepared remarks, illustrate what our CET1 would be on an adjusted basis of 7.9%, one of the highest in the peer group. And so, that's certainly part of the thinking to continue to drive CET1 higher and manage for what will likely come down the pike in terms of that. So we think it's the right plan and we continue to execute on that.

So is there anything you need to see in terms of either the macro environment or clarity on regulation before you [ re-stop ] those buybacks?

Yes, and yes. So I think throughout the course of this year, I think we've got the plan generally set. Over the next 3 months, we'll presumably get more clarity on the regulatory outcomes of Basel III of resolution planning and how AOCI will be treated. We'll also, hopefully, by the end of this year, a much greater clarity on where the economy is heading. And so, we'll go into 2024 and set a new capital plan at that point.

And does that impact how you manage your balance sheet as well on the asset side?

I think over time, I suspect we will continue to evolve as we have been, which is to really continue to drive the highest return loan categories and optimize the balance sheet, make the balance sheet work even harder in the securities portfolio, continue to gradually shorten duration, no substantive changes or major repositioning plan, but just an evolution of where incremental investments are going, I think, is the strategy.

Got it. Are there any questions in the room?

You mentioned having strong sponsors on CRE. I think I am -- sponsors that would have been considered strong a year ago, PIMCO and Brookfield [ are tossing keys ] like crazy. What -- because it's to their economic advantage. So what makes a strong sponsor?

Yes. It's a great question, and I don't disagree with your points. I think for us, it's about the -- what we've seen them do in previous challenging environments and previously challenging situations. And we've seen our sponsors stay committed to their properties and stay committed to their investments. It's also the breadth of our relationship with them, which matters. And I think we matter to them and they, I think, take that position with a lot of care and diligence. So we'll see. I don't disagree with your point, [ at large ]. But for us, as we deep dive into that book, continue to see, not only strength of the properties, but also feel good about the underlying support as well.

All right. We'll end it there. Zach, thanks so much for your time.

Thank you. Have a great day, everybody.